Clause 1

Decline of the Forbidden Subject Matter Test.

The Su- preme Court has restored to Congress the power to tax most of the subject matter which had previously been withdrawn from its reach by judicial decision. The holding of Evans v. Gore540 and Miles v. Graham541 that the inclusion of the salaries received by federal judges in measuring the liability for a nondiscriminatory income tax violated the constitutional mandate that the compensation of such judges should not be diminished during their continuance in office was repudiated in O’Malley v. Woodrough.542 The specific ruling of Collector v. Day543 that the salary of a state officer is immune to federal income taxation also has been overruled.544 But the principle underlying that decision—that Congress may not lay a tax that would impair the sovereignty of the states—is still recognized as retaining some vitality.545

Federal Taxation of State Interests.

In 1903 a succession tax upon a bequest to a municipality for public purposes was upheld on the ground that the tax was payable out of the estate before distribution to the legatee. Looking to form and not to substance, in disregard of the mandate of Brown v. Maryland,546 a closely divided Court declined to “regard it as a tax upon the municipality, though it might operate incidentally to reduce the bequest by the amount of the tax.”547 When South Carolina embarked upon the business of dispensing alcoholic beverages, its agents were held to be subject to the national internal revenue tax, the ground of the holding being that in 1787 such a business was not regarded as one of the ordinary functions of government.548

Another decision marking a clear departure from the logic of Collector v. Day was Flint v. Stone Tracy Co.,549 in which the Court sustained an act of Congress taxing the privilege of doing business as a corporation, the tax being measured by the income. The argument that the tax imposed an unconstitutional burden on the exercise by a state of its reserved power to create corporate franchises was rejected, partly because of the principle of national supremacy, and partly on the ground that the corporate franchises were private property. This case also qualified Pollock v. Farmers’ Loan & Trust Co. to the extent that it allowed interest on state bonds to be included in measuring the tax on the corporation.

Subsequent cases have sustained an estate tax on the net estate of a decedent, including state bonds,550 excise taxes on the transportation of merchandise in performance of a contract to sell and deliver it to a county,551 on the importation of scientific apparatus by a state university,552 on admissions to athletic contests sponsored by a state institution, the net proceeds of which were used to further its educational program,553 and on admissions to recreational facilities operated on a nonprofit basis by a municipal corporation.554 Income derived by independent engineering contractors from the performance of state functions,555 the compensation of trustees appointed to manage a street railway taken over and operated by a state,556 profits derived from the sale of state bonds,557 or from oil produced by lessees of state lands,558 have all been held to be subject to federal taxation despite a possible economic burden on the state.

In finally overruling Pollock, the Court stated that Pollock had “merely represented one application of the more general rule that neither the federal nor the state governments could tax income an individual directly derived from any contract with another government.”559 That rule, the Court observed, had already been rejected in numerous decisions involving intergovernmental immunity. “We see no constitutional reason for treating persons who receive interest on government bonds differently than persons who receive income from other types of contracts with the government, and no tenable rationale for distinguishing the costs imposed on States by a tax on state bond interest from the costs imposed by a tax on the income from any other state contract.”560

Scope of State Immunity From Federal Taxation.

Although there have been sharp differences of opinion among members of the Supreme Court in cases dealing with the tax immunity of state functions and instrumentalities, the Court has stated that “all agree that not all of the former immunity is gone.”561 Twice, the Court has made an effort to express its new point of view in a statement of general principles by which the right to such immunity shall be determined. However, the failure to muster a majority to concur with any single opinion in the latter case leaves the question very much in doubt. In Helvering v. Gerhardt,562 where, without overruling Collector v. Day, it narrowed the immunity of salaries of state officers from federal income taxation, the Court announced “two guiding principles of limitation for holding the tax immunity of state instrumentalities to its proper function. The one, dependent upon the nature of the function being performed by the state or in its behalf, excludes from the immunity activities thought not to be essential to the preservation of state governments even though the tax be collected from the state treasury. . . . The other principle, exemplified by those cases where the tax laid upon individuals affects the state only as the burden is passed on to it by the taxpayer, forbids recognition of the immunity when the burden on the state is so speculative and uncertain that if allowed it would restrict the federal taxing power without affording any corresponding tangible protection to the state government; even though the function be thought important enough to demand immunity from a tax upon the state itself, it is not necessarily protected from a tax which well may be substantially or entirely absorbed by private persons.”563

The second attempt to formulate a general doctrine was made in New York v. United States,564 where, on review of a judgment affirming the right of the United States to tax the sale of mineral waters taken from property owned and operated by the State of New York, the Court reconsidered the right of Congress to tax business enterprises carried on by the states. Justice Frankfurter, speaking for himself and Justice Rutledge, made the question of discrimination vel non against state activities the test of the validity of such a tax. They found “no restriction upon Congress to include the States in levying a tax exacted equally from private persons upon the same subject matter.”565 In a concurring opinion in which Justices Reed, Murphy, and Burton joined, Chief Justice Stone rejected the criterion of discrimination. He repeated what he had said in an earlier case to the effect that “the limitation upon the taxing power of each, so far as it affects the other, must receive a practical construction which permits both to function with the minimum of interference each with the other; and that limitation cannot be so varied or extended as seriously to impair either the taxing power of the government imposing the tax . . . or the appropriate exercise of the functions of the government affected by it.”566 Justices Douglas and Black dissented in an opinion written by the former on the ground that the decision disregarded the Tenth Amendment, placed “the sovereign States on the same plane as private citizens,” and made them “pay the Federal Government for the privilege of exercising powers of sovereignty guaranteed them by the Constitution.”567 In a later case dealing with state immunity the Court sustained the tax on the second ground mentioned in Helvering v. Gerhardt—that the burden of the tax was borne by private persons—and did not consider whether the function was one which the Federal Government might have taxed if the municipality had borne the burden of the exaction.568

Articulation of the current approach may be found in South Carolina v. Baker.569 The rules are “essentially the same” for federal immunity from state taxation and for state immunity from federal taxation, except that some state activities may be subject to direct federal taxation, while states may “never” tax the United States directly. Either government may tax private parties doing business with the other government, “even though the financial burden falls on the [other government], as long as the tax does not discriminate against the [other government] or those with which it deals.”570 Thus, “the issue whether a nondiscriminatory federal tax might nonetheless violate state tax immunity does not even arise unless the Federal Government seeks to collect the tax directly from a State.”571

Uniformity Requirement.

Whether a tax is to be appor- tioned among the states according to the census taken pursuant to Article I, § 2, or imposed uniformly throughout the United States depends upon its classification as direct or indirect.572 The rule of uniformity for indirect taxes is easy to obey. It requires only that the subject matter of a levy be taxed at the same rate wherever found in the United States; or, as it is sometimes phrased, the uniformity required is “geographical,” not “intrinsic.”573 Even the geographical limitation is a loose one, at least if one follows United States v. Ptasynski,574 in which the Court upheld an exemption from a crude-oil windfall-profits tax of “Alaskan oil,” defined geographically to include oil produced in Alaska (or elsewhere) north of the Arctic Circle. What is prohibited, the Court said, is favoritism to particular states in the absence of valid bases of classification. Because Congress could have achieved the same result, allowing for severe climactic difficulties, through a classification tailored to the “disproportionate costs and difficulties . . . associated with extracting oil from this region,”575 the fact that Congress described the exemption in geographic terms did not condemn the provision.

The clause accordingly places no obstacle in the way of legislative classification for the purpose of taxation, nor in the way of what is called progressive taxation.576 A taxing statute does not fail of the prescribed uniformity because its operation and incidence may be affected by differences in state laws.577 A federal estate tax law that permitted deduction for a like tax paid to a state was not rendered invalid by the fact that one state levied no such tax.578 The term “United States” in this clause refers only to the states of the Union, the District of Columbia, and incorporated territories. Congress is not bound by the rule of uniformity in framing tax measures for unincorporated territories.579 Indeed, in Binns v. United States,580 the Court sustained license taxes imposed by Congress but applicable only in Alaska, where the proceeds, although paid into the general fund of the Treasury, did not in fact equal the total cost of maintaining the territorial government.

Social Security Act Cases.

Although the Court in Butler held that the spending power is not limited by the specific grants of power contained in Article I, § 8, the Court found, nevertheless, that the spending power was qualified by the Tenth Amendment, and on this ground ruled that Congress could not use moneys raised by taxation to “purchase compliance” with regulations “of matters of state concern with respect to which Congress has no authority to interfere.”624 Within little more than a year this decision was narrowed by Steward Machine Co. v. Davis,625 which sustained the tax imposed on employers to provide unemployment benefits, and the credit allowed for similar taxes paid to a state. To the argument that the tax and credit in combination were “weapons of coercion, destroying or impairing the autonomy of the states,” the Court replied that relief of unemployment was a legitimate object of federal expenditure under the “general welfare” clause, that the Social Security Act represented a legitimate attempt to solve the problem by the cooperation of state and Federal Governments, and that the credit allowed for state taxes bore a reasonable relation “to the fiscal need subserved by the tax in its normal operation,”626 because state unemployment compensation payments would relieve the burden for direct relief borne by the national treasury. The Court reserved judgment as to the validity of a tax “if it is laid upon the condition that a state may escape its operation through the adoption of a statute unrelated in subject matter to activities fairly within the scope of national policy and power.”627

Conditional Grants-in-Aid.

It was not until 1947 that the right of Congress to impose conditions upon grants-in-aid over the objection of a state was squarely presented.628 The Court upheld Congress’s power to do so in Oklahoma v. Civil Service Commission.629 The state objected to the enforcement of a provision of the Hatch Act that reduced its allotment of federal highway funds because of its failure to remove from office a member of the State Highway Commission found to have taken an active part in party politics while in office. The Court denied relief on the ground that, “[w]hile the United States is not concerned with, and has no power to regulate local political activities as such of state officials, it does have power to fix the terms upon which its money allotments to states shall be disbursed. . . . The end sought by Congress through the Hatch Act is better public service by requiring those who administer funds for national needs to abstain from active political partisanship. So even though the action taken by Congress does have effect upon certain activities within the state, it has never been thought that such effect made the federal act invalid.”630

The general principle is firmly established. “Congress has frequently employed the Spending Power to further broad policy objectives by conditioning receipt of federal moneys upon compliance by the recipient with federal statutory and administrative directives. This Court has repeatedly upheld against constitutional challenge the use of this technique to induce governments and private parties to cooperate voluntarily with federal policy.”631

The Court has set forth several standards purporting to channel Congress’s discretion in attaching grant conditions.632 To date only one statute, discussed below, has been struck down as violating these standards, although several statutes have been interpreted so as to conform to the guiding principles. First, the conditions, like the spending itself, must advance the general welfare, but the determination of what constitutes the general welfare rests largely if not wholly with Congress.633 Second, because a grant is “much in the nature of a contract” offer that the states may accept or reject,634 Congress must set out the conditions unambiguously, so that the states may make an informed decision.635 Third, the Court continues to state that the conditions must be related to the federal interest for which the funds are expended,636 but it has never found a spending condition deficient under this part of the test.637 Fourth, the power to condition funds may not be used to induce the states to engage in activities that would themselves be unconstitutional.638 Fifth, the Court has suggested that in some circumstances the financial inducement offered by Congress might be so coercive as to pass the point at which “pressure turns into compulsion.”639 Certain federalism restraints on other federal powers seem not to be relevant to spending conditions.640

In 2010, Congress passed the Patient Protection and Affordable Care Act (ACA),641 which established a comprehensive health care system for the United States. As part of this new system, the Act expanded which persons were eligible for Medicaid, which is financed jointly by the federal and state governments. Failure of a state to implement such expansion could, in theory, have resulted in the withholding of all Medicaid reimbursements, including payments for persons previously covered by the Medicaid program. In National Federation of Independent Business (NFIB) v. Sebelius,642 seven Justices (in two separate opinions) held that the requirement that states either comply with the requirements of the Medicaid expansion under the ACA or lose all Medicaid funds violated the Tenth Amendment.643 The Court held, however, that withholding of just the funds associated with that expansion raised no significant constitutional concerns, essentially making the Medicaid expansion voluntary.

Chief Justice Roberts’ controlling opinion644 in NFIB held that the ACA Medicaid expansion created a “new” and “independent” program.645 As Congress’s power to direct state activities under the Spending Clause is in the nature of a contract, Justice Robert’s opinion suggests that the only changes that could be made to Medicaid would be those that could be reasonably anticipated by the states as they entered the original program, when only four categories of persons in financial need were covered: the disabled, the blind, the elderly, and needy families with dependent children. The Medicaid expansion arguably changed the nature of the program by requiring recipient states, as part of a universal health care system, to meet the health care needs of the entire nonelderly population with income below 133% of the poverty level.646 Thus, the Medicaid expansion “accomplishe[d] a shift in kind, not merely degree.”647

Once Justice Roberts established that the Medicaid expansion was a “new” and “independent” program, he then turned to whether withdrawal of existing Medicaid funds for failure to implement the expansion was coercive. Justice Roberts noted that the threatened loss of Medicaid funds was “over 10 percent of most State’s total revenue,” which he characterized as a form of “economic dragooning” which put a “gun to the head” of the states.648 Justice Roberts contrasted this amount with the amount of federal transportation funds threatened to be withheld from South Dakota in Dole, which he characterized as less than half of one percent of South Dakota’s budget. How courts are to consider grant withdrawals between 10 percent and one-half of 1 percent, however, is not addressed by the Roberts’ opinion, and Justice Roberts declined to speculate where such a line would be drawn.

If a state accepts federal funds on conditions and then fails to follow the requirements, the usual remedy is federal administrative action to terminate the funding and to recoup funds the state has already received.649 Although the Court has allowed beneficiaries of conditional grant programs to sue to compel states to comply with the federal conditions,650 more recently the Court has required that any such susceptibility to suit be clearly spelled out so that states will be informed of potential consequences of accepting aid. Finally, it should be noted that Congress has enacted a range of laws forbidding discrimination in federal assistance programs,651 and some of these laws are enforceable against the states.652

Earmarked Funds.

The appropriation of the proceeds of a tax to a specific use does not affect the validity of the exaction, if the general welfare is advanced and no other constitutional provision is violated. Thus a processing tax on coconut oil was sustained despite the fact that the tax collected upon oil of Philippine production was segregated and paid into the Philippine Treasury.653 In Helvering v. Davis,654 the excise tax on employers—the proceeds of which were not earmarked in any way, although intended to provide funds for payments to retired workers—was upheld under the “general welfare” clause, the Tenth Amendment’s being found inapplicable.

Debts of the United States.

The power to pay the debts of the United States is broad enough to include claims of citizens arising on obligations of right and justice.655 The Court sustained an act of Congress which set apart for the use of the Philippine Islands, the revenue from a processing tax on coconut oil of Philippine production, as being in pursuance of a moral obligation to protect and promote the welfare of the people of the Islands.656 Curiously enough, this power was first invoked to assist the United States to collect a debt due to it. In United States v. Fisher,657 the Supreme Court sustained a statute that gave the Federal Government priority in the distribution of the estates of its insolvent debtors. The debtor in that case was the endorser of a foreign bill of exchange that apparently had been purchased by the United States. Invoking the Necessary and Proper Clause, Chief Justice Marshall deduced the power to collect a debt from the power to pay its obligations by the following reasoning: “The government is to pay the debt of the Union, and must be authorized to use the means which appear to itself most eligible to effect that object. It has, consequently, a right to make remittances by bills or otherwise, and to take those precautions which will render the transaction safe.”658